global investing: a stock perspective · achievable through investing in individual stocks. 28-33...

Global investing: a stock picker’s perspective

The unprecedented pace of change that is taking place today across the world, thanks in part to huge leaps in technology, can make investing seem a daunting task to the uninitiated.

INTRODUCTION

ith many of the world’s leading companies

listed overseas, access to their share

register can be difficult, keeping tabs on

them can be time consuming and understanding the

effects of foreign exchange on the share price can

be confusing.

At JM Finn we invest clients’ assets by selecting

those companies and funds that have an anticipated

return profile that best meets the clients’ investment

objectives, in the eyes of their investment managers.

These investment decisions are made with the help

of our research team, third party analysis and an

open and discursive investment approach across

the firm. This process empowers our investment

managers to make decisive and committed

investment decisions.

A core aspect of the firm’s investment approach is

bottom-up stock picking; that is to say an approach

that looks to invest in companies that will be future

winners, as opposed to a top-down investor, where

you might select the region you want to invest in and

then choose the companies. In today’s connected

and fast changing world, finding the winners needs

a wider lens beyond an investor’s domestic market.

Rather than looking to access global growth via the

UK stock market alone, a stock picker has a much

larger universe of potential winners if the net is cast

across the globe.

WIn this report we have brought together the thoughts

of a variety of authors, both internal and external,

that corroborate the view that to take advantage of

the structural change taking place across the world, a

global standpoint is required.

Although many private investors are unable to buy

Chinese-listed equities, that does not mean they

should ignore them if they might be the future global

leaders. By using a wealth manager with a platform

for access to global investments, investors can open

themselves up to more opportunity, not forgetting

of course, that investing doesn’t always mean

making money, as stock markets fluctuate; whether

you invest in the UK or China, Japan or the US, you

may end up with less money than you started with.

However, whatever outcome you are seeking from

your investments, having a well diversified portfolio

across a range of asset classes and geographies is a

sensible starting point.

3JM Finn Investment | Wealth


Case StudyChanging the system in Saudi Arabia

Featured Articles

06-09

Hard Darwin

John Royden CFA, Head of Research at

JM Finn looks at the rate of corporate

turnover and the resultant changing

shape of the world’s largest companies.

42-47

Change – for better

or for worse?

With a career spanning more than half a century,

Brian Tora reflects on the dramatic changes that

have occurred in the opportunities and approaches

available to investors during his lifetime and why the

pace of change may quicken further.

22-23

Case Study

Changing the system in Saudi Arabia

A look at the ambitious plans of Saudi Arabia as

it attempts to shift from one of the world’s last

feudal monarchies to a modern nation-state.

4 JM Finn Investment | Wealth


Contents

10-15

The Global Economy; the driving forces

Neil Mackinnon, global investment strategist,

looks at the reasons why global growth

expectations are at a two year low.

16-21

Emerging Markets: still a relevant

asset class?

Cherry Reynard, award winning journalist,

suggests that the emerging markets are a good

investment opportunity because they are home

to some of the world’s fast-growing companies

and sectors.

24-27

Putting it into practice: a practitioner’s view

Investment director, Matthew McEneaney, explains

why he is drawn to the transparency and focus

achievable through investing in individual stocks.

28-33

Why our backyard is too small

The research team at JM Finn have a series of

filters by which they view potential investment

opportunities. By casting the net wider to

include global companies, the universe of

opportunity is far greater.

34-39

What are the effects of FX?

Investing globally requires an understanding

of the effects foreign exchange can have on

your investment. James Godrich explains

how FX can be managed.

40-43

The US, the U.K. and company creation

The manager of one of the UK’s largest

investment trusts is sad that we don’t breed

any of the world’s most successful tech

companies here in the UK.

48-51

The FTSE – No Man is an Island

Fred Mahon gives a strong defence for

investing in the UK as part of a balanced,

global investment portfolio.

52-53

Understanding finance

We extend our educational series to help

investors understand some of the terms

investment managers use when looking to

evaluate investment opportunities.



Hard Darwin

ontrary to popular belief, Darwin did not

explicitly say that “it is not the strongest

of the species that survives, nor the most

intelligent that survives. It is the one that is most

adaptable to change”; rather, it is an oft-quoted

summary of his most famous work. Whilst the idea

did grow from the Origin of Species, we can also see

the need for adaptability in the cut throat world of

corporations and the rate at which they “die” or fade

into obscurity. Going bust (usually too much debt),

losing market share, being split up by anti-trust

legislation and being bought are the most common

corporate afflictions.

The rate of corporate turnover is increasing. In 1965

companies stayed in the S&P500 for an average

of 33 years. By 1990, it was 20 years, and by 2012

down to 18 years. It looks as if it is heading to 14

years by 2026. That means that at the current

churn rate, about half of the S&P 500 firms will be

replaced over the next ten years as we enter a stretch

of accelerating change in which lifespans of big

companies are getting shorter than ever1.

Why, we ask ourselves? Schumpeterian creative

destruction2 is about the idea that market disruption

is being driven by the endless pursuit of sales and

profits that can only come from serving customers

with low prices, high quality products and services,

and great customer service. We now live in more

Author

John Royden Head of Research, JM Finn

C

HALF OF THE S&P 500 FIRMS WILL BE REPLACED OVER THE NEXT TEN YEARS.



complex, faster-moving times where the impacts of

globalisation, shifts in technology, the challenges

of regulatory compliance and shifts in customer

demand are all exacerbated by the speed of

information delivery across the internet.

You can see this at the top of the league tables of

global stocks, or indices, as well as at the bottom.

Looking at MSCI’s All Country World Index or ACWI

we can see that just five years ago Financials,

20% of the market capitalisation, was just larger

than Information Technology (19%). Since then

Information Technology has gained a further 13% at

the cost of Consumer Staples (-4%), Energy (-6.4%)

and Financials (-4%)3.

Back in 2013, Apple, Exxon, General Electric, Chevron,

Nestle, IBM, Microsoft, Procter & Gamble, Johnson &

Johnson were the top ten global companies by market

capitalisation. Of the top 100 companies, the US

dominated with 61% of market capitalisation followed

by the UK with 12%. China only accounted for 1%4.

Fast forward to 2018 and the top ten list runs as

follows: Apple, Microsoft, Amazon, Facebook, JP

Morgan Chase, Johnson & Johnson, Alphabet (was

Google), Tencent, Exxon and Bank of America.

China has now grown to represent 4% (from 1%)

of the market capitalisation to the detriment of the

THE RATE OF CORPORATE TURNOVER IS INCREASING

NUMBER OF YEARS, ON AVERAGE, COMPANIES STAYED

IN THE S&P500

2012

2026

1990

IN NUMBERS

1965



UK which has seen its share half to 6%. The big

surprise though has been to see the share of US

companies grow from 61% in 2013 to 73% today.

We can attribute that statistic to the growth of the

US’s technology companies, but did we realise the

huge size of the impact?

Casting back further into history, the top ten in 1967

included names like Eastman Kodak, Standard Oil and

Polaroid. Run back a century and your list included the

now mostly unknowns like US Steel, Bethlehem Steel,

Armour, Swift & Co, International Harvester, Midvale

Steel and US Rubber. AT&T would probably be the

only company that most of us would recognise today.

So where is all this taking us? As the rate of attrition

speeds up it would not be beyond one’s imagination

to think that anti-oligopolistic legislation could

account for a cull of the banks out of the top ten. Will

that also work for the technology companies to the

point where perhaps three of the current six fade to

oblivion? Or will it be new companies displacing the

old with little more than a download click on a slightly

better app?

Whatever happens, you can rest assured that we

will be looking for it as we scour the world for

investment opportunity and reward, whilst at the

same time keeping an eye on those showing the first

signs of fatigue, product obsolescence or adverse

regulatory change.

Fig. 1. Geographical representation of the

MSCI All Country World Index5

AUSTRALIA

CHINA

GERMANY

JAPAN

UK

US

-4%

2%

-

-1%

-6%

12%

20182013



The Global Economy: the driving forces



China is the

biggest foreign

official holder of

US Treasuries.

Author

Neil MacKinnonGlobal macro strategist, VTB Capital in London



he view from the International

Monetory Fund (IMF), the Organisation

for Economic Co-operation and

Development (OECD) and other forecasting bodies

(not always noted for their forecasting accuracy!) is

that the global economy is enjoying a broad-based

synchronized recovery that can at least extend into

next year. Even the Eurozone is catching up after a

long period of low growth and high unemployment

while the US economy is expected to derive a short-

term boost from President Trump’s tax cuts and

increases in spending, though this seems to be at

the expense of prospective trillion-dollar budget

deficits and a gross federal debt-GDP ratio that

rises to above 100%. America’s “twin deficits” and

America’s reliance on foreign funding, especially

from China which is the biggest foreign official

holder of US Treasuries6, is perhaps a reason why

the US dollar has been languishing over the last year

or so.

The IMF note that Emerging Market Asia will

account for half of this year’s global growth. China is

included in this category though economic growth

here is on a longer-run trajectory of declining growth

reflecting adverse demographics, a necessary

de-leveraging of China’s widely-documented

credit binge as well as the fall-out from making

the transition from an investment-led economy.

Japan is recovering but its growth rate is fairly

anaemic and the economy is still finding it difficult

to move decisively away from a deflationary mind-

T

Volatility is back

on the agenda



set despite, or maybe because of, a long period of

radical monetary policies.

It is instructive that a long period of “unconventional”

monetary policies has only yet provided a growth

impetus, although there are many commentators

critical of such policies, described as “Bubble

Finance,” in actually creating financial asset price

problems and distortions to saving and investment.

After the February 2018 sell off in equity markets, at a

time of historic extremes in US equity valuations, an

increase in volatility may be back on the agenda.

Perhaps the changing political landscape and voter

rejection of fiscal austerity and “establishment”

thinking paves the way for much looser fiscal

policies in the medium term, though record levels

of global debt are a constraint and in many cases

there is excess leverage. In the Eurozone, the fiscal

stance remains the tightest of any of the major

economies. Higher inflation is the traditional route

used by policymakers in reducing debt accordingly;

inflation is creeping up but structural factors such

as technological change and the “Amazon effect” in

addition to low productivity might keep inflation in

check. A return of the commodity super-cycle seems

unlikely as the Chinese boom fades and technological

change in the energy sector caps oil prices.

For the major economies generally, the decade-long

experiment in QE (Quantitative Easing) and zero/

negative interest rates is coming to an end. The Fed

THE MOST CROWDED TRADE

Bank stocks are at the 2nd highest over-

weight position in the survey’s history

#1

#2

SNAPSHOT

Fig. 2. The US Yield Curve7

0.25 2 5 7 10 20 30

4

3

2

1

0

TREASURY YIELD CURVES

Years to Maturity

Yie

ld t

o M

atu

rity

(%

)

DECEMBER 2018DECEMBER 2019 CURRENT



has already started to unwind its US$4.5 trillion

balance sheet that mainly consists of its purchases

of US debt and by October 2018, the liquidity

withdrawal will amount to an annualised US$600

billion. The new-look Fed under Jerome Powell

seems to have a more hawkish tilt and three 0.25%

rate hikes are already discounted but a fourth hike,

in conjunction with the aforementioned liquidity

withdrawal, might be a step too far.

The flattening in the US yield curve, a traditional

indicator of a US recession, is suggesting that the

markets are perhaps becoming more worried about

growth risks rather than inflation risks. Economists

who believe that money supply growth determines

nominal GDP growth (a view that is absent at most

central banks) note that currently global money

supply growth is at its lowest since November 2007,

thus presaging at some point later in 2018 slower

economic growth and subdued inflation.

More recently, it is the prospect of a global trade

war resulting from a more protectionist US trade

policy that is weighing on equity markets. The

latest annual Bank of America Merrill Lynch

(BoAML) Fund Manager Survey cited a global trade

war as the main “tail risk” followed by “stagflation”

as global growth expectations for respondents in

the survey was at its lowest since July 2016; and

more importantly inflation expectations are at

their highest since June 2004. Retaliatory action

from the EU and China against the imposition of

US tariffs on steel and aluminium imports and

threats against EU car imports, as well as a US$60

billion surcharge on a range of Chinese products,

endanger the consensus view of continuing

expansion in the global economy.

As far as the UK economy is concerned, the range

of economic calamities envisaged by Project

Fear propagandists on the back of the Brexit

referendum vote, such as recession and higher

unemployment, failed to materialize. I suppose

they continue to live in hope; not that Brexit

abolishes the business cycle. Brexit is about

taking control as an independent sovereign state

over laws, regulations and our borders with the

freedom to negotiate our own trade deals and take

advantage of prospects in the global economy. We

are not the only ones to think this, as the results of

the recent Italian elections made clear.

Whether the transitional deal with the EU actually

delivers a proper Brexit or a “vassal state” I will

leave to readers’ discretion. In the meantime, an

interesting result from the BoAML Fund Manager

Survey is an all-time low in exposure to UK equities

suggesting a “buy” for contrarian investors. The

most crowded trade is a long position in FAANG

stocks followed by short positions in the US dollar.

Bank stocks are at the 2nd highest over-weight

position in the survey’s history. Interesting

times ahead!

It is the prospect of

a global trade war

that is weighing on

equity markets



Emerging Markets: still a relevant catch all asset class?

Author

Cherry ReynardFive-time winner of the

AIC freelance journalist

of the year award (2011,

2012, 2013, 2014, 2015)

and six-time winner

of the IMA freelance

journalist of the year

award (2008, 2009, 2010,

2011, 2013, 2016), Cherry

has co-authored a book

– Investing in Emerging

Markets; the BRIC

economies and beyond,

published in 2010.



ow helpful is the term ‘emerging

markets’? In theory, it suggests that

countries have certain common and

recognisable characteristics, but the emerging

markets universe today is far more diverse than this

catch-all would suggest.

While the short-hand has been to see all emerging

markets as cyclical, commodity-dependent and

dollar-sensitive, that is not the reality for many

developing countries. The ‘emerging markets’

classification incorporates countries at vastly

different stages of economic development. South

Korea remains on the cusp of being considered a

developed market, while Pakistan has only just lost

its ‘frontier’ tag.

There are clear differences in how these countries

generate wealth. Russia remains largely dependent

on natural resources to fuel its economic growth,

while China has become a hotbed for innovative

consumer technology as it moves away from its

historic dependence on manufacturing.

Emerging market countries have varying exposure

to hard currency, which in turn determines their

vulnerability to changes in developed market

monetary policy. For example, Turkey, Argentina

and Peru have almost half of their outstanding

bonds denominated in foreign currency. This may

be positive or negative at different times, but it gives

the country a different profile to, say, India, which

has less than 5%8.

At the same time, countries that are reliant on

foreign inflows to support their debt are also

exposed to international sentiment. Companies

with a strong domestic market for their government

debt, with well-established pension funds and

insurance sectors, are likely to find ready buyers,

whereas those who depend on the favours of foreign

buyers are dependent on global conditions.

They also vary in the extent to which they are exposed

to the US. Mexico, for example, should be a natural

beneficiary of the US fiscal stimulus, for example,

though there remain uncertainties around the North

American Free Trade Agreement (NAFTA) deal. That

might also spread to other parts of Latin America.

However, its effect is unlikely to be felt to any great

degree in Eastern Europe or in parts of Asia.

It also extends to the adoption of technology. At

over $1trillion, China is now the largest ecommerce

market in the world. Online retailing in China is

expected to grow from 17% of total retail sales in

2017 to 25% in 20209. 52% of Chinese consumers

shop on their mobile on a daily or weekly basis. This

outpaces the 46% that shop in-store10.

H



THE ADOPTION OF TECHNOLOGY

ONLINE RETAILING

CONSUMER SHOPPING

+$1trillionThe largest ecommerce

market in the world

China

China’s projected growth

in total retail sales

17%

25%

52% 46%

2017

MOBILE IN-STORE

2020



Countries that are

reliant on foreign inflows

to support their debt

are also exposed to

international sentiment

A similar pattern is emerging in India. The Indian

e-commerce market is expected to grow to US$200

billion by 2026 from US$38.5 billion last year and

cross US$ 50 billion this year. India has widespread

internet and smartphone penetration, which creates

an easy path for the spread of ecommerce11. While

Russia’s ecommerce market is growing fast, it

remains a minnow at around $8.8bn12. Brazil’s

ecommerce market is larger, but still in the early

stages of development.

This creates different opportunities. The MSCI China

now has 41.5% in technology, notably in its two

flagship internet companies, TenCent and Alibaba

(18.5% and 12.6% respectively). Materials are just

4% and energy is just 2.6% of the index. In contrast,

the MSCI Brazil has 37% of its market capitalisation

in financials, and six of its top ten holdings.

Materials and energy also feature heavily, with a

lowly 2.1% in technology and 1.7% in healthcare.

Russia perhaps conforms best to the traditional

idea of a commodity driven emerging market. Its

economy is still largely reliant on oil and other natural

resources. Energy is 48.5% of the MSCI Russia index.

There are no technology companies large enough to

find a place in the index and its consumer sector is

nascent – just 3.6% of the index13.



For 2017, this meant that although the aggregate

performance of emerging markets looked strong,

it masked huge disparity in the performance of

individual companies. Just looking at some of the

largest companies, Alibaba’s share price doubled

over the year, while that of Russia Oil giant Gazprom

– the largest company in the Russian index - dropped

16%. Brazilian brewing giant Ambev rose 35% over

the year (source, FT, 12 months to 31 December).

This disparity in the returns for individual

companies drove significant differences between

individual countries. Last year, Asian markets

soared, largely driven by the large Chinese Internet

names, but emerging market fund managers who

had directed capital to more ‘old economy’ areas

fared less well.

The key point is that emerging markets present very

different opportunities at different stages of the

economic cycle. This disparity may become more

acute as global monetary policy shifts or the effects

of US tax cuts are felt around the world.

The solution is to treat emerging markets not as

an homogenous grouping, but to dig deep and look

for the strongest companies. Emerging markets

are increasingly home to companies that are

global leaders – Alibaba and TenCent are closely

watched by US competitors, who recognise that

they are driving new innovation; Samsung continues

to prove a worthy rival to Apple, while Taiwan

Semiconductors heads its sector.

Emerging markets are no longer a good opportunity

just because it’s the right time in the cycle, they

offer good opportunity because they are home to

fast-growing companies and sectors that often

don’t exist elsewhere. A nuanced, stock picking

approach is likely to be the best way to capitalise

on the opportunities presented across these

diverse countries.



E-COMMERCE MARKET

$200billion

$50billion

$38.5billion

The growth of the Indian e-commerce market

WIDESPREAD INTERNET AND SMARTPHONE PENETRATION

CREATES AN EASY PATH FOR THE SPREAD OF ECOMMERCE

India 2026

2018

2017



Case StudyChanging the system in Saudi Arabia Author

Marko PapicChief Strategist, Geopolitics BCA Research― ― ― ―BCA is a world leading provider of

independent investment research. Since

1949, the firm has supported its clients in

making better investment decisions through

the delivery of leading-edge economic

analysis and comprehensive investment

strategy research.



Saudi Arabia is in the throes of a painful reform process as it attempts to shift from one of the world’s last feudal monarchies to a modern nation-state.

The Saudi state badly needs to diversify away

from oil. It has also suffered a series of humiliating

setbacks internationally as a result of US

withdrawal from the region.

However, structural reforms require substantive

changes to the political and social system. Three

parallel efforts are under way:

— Curbing the religious establishment:

Since April 2016, Saudi Arabia has

severely curbed the powers of the hai’a

- the country’s religious police. More

broadly, the country’s long-term “Vision

2030” reform blueprint relegates religion

to a more constrained role. Secular

education is to be improved.

— Taking charge of the political and

economic elites: The detention of

members of the Saudi royal family in 2017-

18 was part of an ongoing effort to curb

the powers of the “landed aristocracy”

and bring it under the control of the

ruling Sudairi branch of the royal family.

Power consolidation under King Salman

is meant to put Crown Prince Mohammad

bin Salman in full command to drive the

reforms. Pervasive corruption is to be cut

back, being one of the key supports of

vested interests.

— Rallying the public: The regime faces

popular unrest due to economic pressures

and the fact that the youth share of

the population is 57%. The goal is to

allow more room for social change,

technological savviness, and consumer

and service sector growth. The role of

women in the economy will be promoted.

In the short run, the reform agenda adds political

uncertainty to Saudi Arabia, as well as geopolitical

uncertainty to the broader Middle East as sabre-

rattling with Iran may rise.

In the long run, Saudi Arabia’s attempt to become

a modern nation-state is positive for the country

and its economy. Any failure would be negative

for internal stability with risks to oil production if

social unrest were to increase.

What are the investment implications of the

above? Saudi Arabia’s domestic instability gives

it a powerful interest to maintain “OPEC 2.0,” i.e.

cooperation with Iraq, Iran, Russia and other oil

producers to cut production. The kingdom and

Russia have maintained production discipline in

2017 and extended their deal to the end of 2018,

with an option to review quotas in June 2018. My

view is that Brent prices should average $67 per

barrel over the year. In the second half, however,

the combination of surging production from US

shales, and higher production from OPEC 2.0,

could reverse the draw in global inventories,

pushing Brent to an average $55 per barrel in 2019.

While geopolitical risks may add upside to oil prices

this year, we do not expect events to cause supply

shocks that trigger a global recessionary impulse.

Both Saudi Arabia and Iran remain focused on

internal stability, which incentivises them to cut

production and avoid outright conflict. One of the

main exceptions to this uneasy equilibrium would

be if the US Trump administration were to cancel

the 2015 Iranian nuclear agreement in early May.



Putting it into practice: A practitioner’s view

Author

Matthew McEneaneyInvestment Director, JM Finn― ― ― ―Matthew puts global investing

into the context of his clients’

investment objectives.



y client has sterling liabilities; therefore,

it is appropriate to hold sterling assets.

I I still smile when I hear these words.

Anyone who lives or spends time in the UK inevitably

has sterling liabilities. However, I would challenge

the notion that the real cost of goods and services,

whether school or care home fees, motor vehicles,

household goods, or even the luxury food items we

have become accustomed to consuming is driven

by factors dependent on domestic resources or

economic conditions in this country.

Even a cursory glance at our balance of payments

figure reveals a heavy and rising deficit on all but

invisibles, i.e. financial services. In other words,

there is enormous scope for importing inflation,

through both raw materials and finished products,

driving price increases in this country over which we

have little control. At a very basic level, whether the

investment objective is the preservation or creation

of wealth, I consider it a fundamental concern to

drive or protect capital value in global terms, which I

call “global spending power”.

Globalisation appears to be an irreversible trend

and the last two or three decades have seen the

emergence of giant global corporations across

many sectors of the market. The most recent and

obvious example being the technology stocks,

now amongst the world’s largest. Quite apart from

Globalisation

appears to be an

irreversible trend

I am drawn to the

transparency and

focus achievable

through investing

in individual stocks

M



Investing in the best global businesses will by no means be to the exclusion of UK companies



the investment opportunity these businesses

offer, they also provide the means to disseminate

vast quantities of data. Our industry is a major

beneficiary, giving us instant access to facts and

opinion which not so long ago was either unavailable

or so rudimentary that it came in the form of printed

cards which were updated from time to time. Whilst

it is usually helpful to be able to meet with the

management of companies in which we invest, from

a practical perspective there are few other barriers

to looking beyond our shores and selecting the

most promising stocks in the global universe. I am

drawn to the transparency and focus achievable

through investing in individual stocks rather than

geographical funds, where it can be more difficult to

assess cyclical positioning and business exposure

to particular economies, as opposed to simply being

quoted there. This fits in with our long-standing

practice of bottom up stock selection within a broad

asset allocation framework, differentiating globally

by sector, rather than country of quote.

Leading multinational businesses tend to be

efficient allocators of capital and when they

have products or services which are universally

saleable, they will invest in those regions where the

demographics or demand is most attractive. About

two thirds of the revenue of the FTSE100 stocks is

generated outside of the UK and good examples

of businesses with a focus on growth markets are

Diageo and Unilever. Both are strong in the Indian

market where the discretionary spend of the

burgeoning middle class is rising rapidly.

Our market has more than its share of global mining

businesses, whose performance is not linked to the

UK economy. Conversely, sectors such as Information

Technology have little representation, making it

necessary to look in international markets. There

are also important sectors such as pharmaceuticals

where London quoted global businesses such as

AstraZeneca and GlaxoSmithKline have performed

less successfully than many of their peers listed

overseas. Investing in the best global businesses and

achieving diversification across the major sectors of

the equity market will by no means be to the exclusion

of UK companies, but it is unlikely to be exclusively in

them either.

In the immediate aftermath of the referendum

in June 2016, the London market became

differentiated between businesses with non-sterling

revenues and those with a domestic focus. The

former category outperformed materially as a result

of the weaker pound, whilst the latter has continued

to underperform even after some recovery in

sterling due in part to concerns over our economy,

the expectation of higher interest rates and, in

the well represented utility sector, the prospect of

political or regulatory pressure.

At that time, the benefit of an internationally

diversified portfolio was material, with an

immediate boost to sterling investors from

currency movements alone. The UK’s position in

the international pecking order remains under

threat from both the uncertainty Brexit brings

and the inexorable growth of nations with better

demographics and rising flows of inward investment.

Our economy is still home to innovation and world-

class businesses with access to sophisticated

capital markets but we cannot assume that this will

always be the case. In such circumstances, having a

global approach to both asset allocation and stock

selection is not optional, but a responsible way to

reduce risk and improve diversification in a world

and our place within, which is evolving at a breath-

taking pace.



Why our backyard is too smallAuthor

Theo WyldResearch Analyst



We find ourselves in

the UK with a universe

of multi-national

companies, the majority

of which derive most of

their earnings overseas



or a long time, the London Stock

Exchange has been a desirable place

for a large number of aspiring global

companies to list their shares. The reasons for which

are plentiful; depth of capital, time zone, integrity of

the exchange, trust in the UK legal system, to name

a few. One of the consequences of this is that we

find ourselves in the UK with a universe of multi-

national companies, the majority of which derive

most of their earnings overseas. I think this has

provided a convenient excuse for many investors

not to venture abroad when considering potential

opportunities. However, as I hope to show later on,

this attitude has drastically reduced the probability

of buying the best businesses out there.

Let’s assume that, for simplicity, liquidity

constraints require a market capitalisation of a

company to exceed £500m. In this case, our UK-

listed investable universe totals 441 (this takes the

FSTE All Share combined with those large enough

that list on AIM)14.

This number jumps to 2208 when we include the

Russell 3000 Index (c.98% of the investable US

market). Including Japan adds 909 more, and those

non-UK from the European index, the STOXX 600,

takes the total to 3556. I won’t continue on around

the world, but you get the picture that the UK is just

a fraction of even just the developed markets, in

terms of number.

But are these overseas equities only more

numerous but no more dominant? To illustrate this, I

broke out the universe described above (US, Japan,

Europe) by sector and then ordered them by market

capitalisation. As shown in the table adjacent, it is

clear to see where the UK pulls its weight and the

many sectors in which it does not even feature.

Taking Information Technology as a specific

example: this sector represents 19.0% of the MSCI

All World Index15 but just 2.1% of the FTSE All Share.

In fact, you have to go down to number 104 on the

list by market capitalisation before you hit a UK

listed company in the sector (Sage plc). This is an

example of where it is next to impossible to gain

sufficient exposure relative to a global benchmark

by restricting yourself to UK plcs.

F

SectorNo. of UK

companies in top 10

Consumer Discretionary 0

Consumer Staples 2

Energy 2

Financials 0

Health Care 0

Industrials 0

Information Technology 0

Materials 3

Real Estate 0

Telecommunications Services 2

Utilities 0



By now, you are probably thinking ‘bigger doesn’t

necessarily mean better’ – and you’re right to do

so. But what constitutes a ‘better’ company? This

is highly subjective, but I have listed below a few

key metrics that I look at to screen for a ‘quality’

company. There will always be exceptions to the

rules below but the hope is that this filter weeds

out many of the poor businesses in the universe.

The metrics broadly speaking focus on returns

on investment, balance sheet strength, earnings

growth, and cash conversion.

If we run our 441 UK companies through this criteria,

we find that 31 pass all eight tests. However, if we use

our extended universe that number rises by over 6.5x

to 202. As I said earlier, this sort of analysis relies

greatly on what sort of business one is looking for,

and which attributes one places more importance

on. But, hopefully this gives a feel for the increase in

catchment that comes with widening the net.

What we can do is

give ourselves the

best possible chance

by casting the net

wide in search of the

best businesses

Filters

Market Cap Threshold (£m) 500

ROC (min %) 10

5 yr. av ROE (min %) 10

adj. ND/EBITDA (max) 5

Interest cover (min) 4

Fixed charge cover (min) 2

3 yr. EPS CAGR (min %) 5

3 yr. FCF margin (min %) 8



It might now be useful to discuss a real world

example of where taking a global view paid

dividends for shareholders over the long-term. We

have an investment-focussed book club here at JM

Finn, and our March publication was the biography

of legendary investor Sir John Templeton, written

by his niece and nephew (Investing the Templeton

Way). I will steal their affectionate name and refer to

him as Uncle John from now on.

I won’t try and summarise his life, apart from

anything because I recommend you read the book,

but rather pick out a few highlights of his career

when his willingness to look outside the comfort of

his own US universe reaped great reward. I think

Uncle John is a particularly good example because

‘his country views are the result of an assimilation

of bottom-up analysis rather than starting with

some view of the top-down level on the country’s

GDP, outlook for employment, or the like.’16 I.e.

he is directly picking from the larger addressable

universe of companies.

In the 1960s there was a view amongst US investors

that the US was the be all and end all. Uncle John,

never to pass up on a bargain or afraid to get his

hands dirty, identified Japan as a market vastly

under-researched and unloved. Various accounting

difficulties and lack of information provided an easy

excuse for many to shun the region, but Uncle John

was unperturbed. He ended up investing heavily in

selected Japanese equities and rode the meteoric

rise over the next few decades, selling out before

the, then, bubble burst in the 1990s.

South Korea in the late 1990s was a similar

experience both in reasoning and reward. In

these instances his track-record pulled away

from the majority of his US mutual fund peers

and he solidified his reputation as a legendary

investor. Admittedly, a significant portion of his

outperformance can be attributed to analytical skill

and insight, but there’s no doubt in my mind that his

more global outlook played a large part.

We can’t all hope to be even a fraction as successful

as Uncle John, but what we can do is give ourselves

the best possible chance. And that is by casting the

net wide in search of the best businesses, in the best

geographies, offering the best potential returns to

shareholders and therefore to our clients.

Universe of companies

UK 31

Global * 202

*UK, USA, Japan, Europe (ex-UK)

441 31

202

UK COMPANIES 100% PASS

100% PASS



What are the effects of FX?

Author

James GodrichResearch Analyst, JM Finn

Translational FX

risk arises when a

foreign subsidiary

converts its financial

statements into the

reporting currency of

the parent company



n a universe of sterling denominated

investments, shareholder returns

are made up only of returns from

the underlying holdings. But in a world of global

investments, shareholder returns are made up

of both returns from the underlying holdings and

returns from the foreign currency in which those

investments are held.

If we first consider the impact of foreign exchange

(FX) on returns from the underlying holdings, we

might begin by analysing the events following the

Brexit vote in June 2016. In response to this event

the UK’s two main indices, the FTSE100 (the largest

100 stocks by market cap) and the FTSE250 (the

next 250 largest stocks by market cap) moved in

opposite directions. Whilst the long term political

and economic pros and cons of the vote can and

will continue to be debated by both sides, one

undeniable short term impact was on FX through

the immediate and sharp weakening of sterling.

One week after the vote, and following that

sterling devaluation, the more global FTSE100

index celebrated a, mostly FX driven translation

tailwind as it rose 2.6% from its pre-Brexit level.

However, over the same time and as a result of that

same sterling devaluation, the more domestically

oriented FTSE250 index suffered from an FX

transaction headwind and was down more than 6%

from its pre-Brexit level.

Translational FX risk arises when a foreign

subsidiary converts its financial statements into the

reporting currency of the parent company. What this

means is that where Diageo, for example, convert

their overseas earnings into sterling (either actually

IA passive FX strategy

allows currency

returns to impact

the overall portfolio

without intervention



or for accounting purposes), the movement in FX

may cause a gain or a loss depending on the time

at which revenue was received versus the reporting

date for the accounts.

This was highlighted in June 2016 where any recent

earnings from overseas subsidiaries would be

translated at the next reporting date with some

impact from the now weaker sterling. Overseas

revenue would be worth more in sterling terms and

hence would inflate reported earnings. As a result,

the more global earnings from the FTSE100 drove

the index higher.

Transactional FX risk however looks at the

financial impact from a currency move between

the points at which a purchase is made in one

currency and settled in another. To understand

the impact on a business we could consider, for

example, a UK buildings merchant, such as Travis

Perkins, who might import the vast majority of

its stock, therefore making payments (purchase)

on inventory in overseas currency, before

selling (settling) those same goods to domestic

customers in sterling.

In June 2016 following the sterling devaluation,

a number of UK businesses were left with an

effective increase in sterling costs from product

lines denominated in foreign currency. At this point

they were forced to make a decision to raise prices

and risk market share loss or suffer a contraction

in margins. The result of this was greater pressure

on the more domestically focussed FTSE250.

So whilst we as investors have always considered

returns from the stocks in which we invest, another

consideration in a world of global investing is of

returns from the foreign currency in which those

investments are held. This is a form of translation

FX risk, similar to that experienced by businesses.

If we imagine a scenario in which a Labour election

victory causes another significant devaluation

in sterling, our overseas investments will see a

positive currency return as their earnings and

share price are translated back into our domestic

currency. Good news for our overseas investments,

not such good news for our holidays!

However on the contrary, a successful Brexit and

a united Conservative party might see a different

outcome where sterling continues to strengthen

from its, still recent, lows. The result here is that

overseas earnings translate into fewer pounds and

currency returns act as a headwind to our global

investments.

This additional risk therefore implies a further layer

of decision making for us as investors.

A passive FX strategy allows currency returns to

impact the overall portfolio without intervention.

This would be appropriate for investors who believe

that FX markets are broadly efficient and that

returns from currency will be mean reverting in the

long run.

An active strategy on the other hand can come

in various forms, but would be appropriate for

investors who either consider the FX markets to be

inefficient or who are more concerned with short

term fluctuations. Active strategies could vary

from an investor who looks to entirely hedge out



TRANSACTIONAL FX RISK: TRAVIS PERKINS

TRANSLATIONAL FX RISK: DIAGEO

Travis Perkins

PLC

Diageo

PLC

TRAVIS PERKINS UK

Norway

Sweden

Finland

$£

£

€

£

¥N€



(mainly through the use of complex derivatives),

and therefore remove currency risk from their

investment, to one who would look to use active

currency management to increase currency risk as

an additional source of alpha generation.

Whilst we would not look to use derivatives

to hedge out currency risk in direct equity

investments, we may use hedged lines of third

party funds to benefit from a macroeconomic

view. For example, in the recent past we had taken

the view that Japan as a region would be a good

investment, driven by a strong dollar and weak yen

making Japanese exports comparatively cheaper.

Under this assumption any returns driven by the

underlying holdings could have been offset by

currency losses so we would have chosen to have

bought the hedged line of a third party fund.

In a world of global investing the question remains

for our underlying holding returns – what are the

inherent translational and transactional risks within

the underlying business and how does the executive

team manage this? However we must also ask

ourselves how does the currency return impact our

global investments and how should we best manage

this as an investor in overseas securities?

QUESTION?

We must ask

ourselves, how does

the currency return

impact our global

investments and

how should we best

manage this?



Author

James AndersonPartner, Baillie Gifford

James is partner at Baillie

Gifford and manager of

the Scottish Mortgage

Investment Trust, one of

the UK’s largest investment

trusts, with more than £6

billion of total net assets as at

December 2017.

The US, the UK and company creation



’m sitting in the sunshine with a

fashionable coffee at the Cool Cafe in

Menlo Park Business Park. There are

Teslas in the car park and I’m waiting for my Lyft

after meeting the extremely impressive new CEO

of Grail. Grail may be able to make most cancers

curable. So I’m living the clichés but what’s the

substance? Why doesn’t this happen in Britain? Is it

chance or more serious?

The best conceptualisation that I’ve heard of why

new companies flourish comes not from the left

coast of America but from the right side of China.

Robin Li of Baidu opines that 3 characteristics are

required: lots of nerds, serious venture capitalists

and markets of scale. Everyone now has nerds

and most venture capitalists at least pretend to

be global. This leaves us with markets at scale. For

sure China and America offer this but nowhere

else does; it’s conceivable India will but it’s already

been colonised by Sino-America before this can be

clarified. So perhaps we just need to accept this and

move on. QED so to say.

But although this is appealing I don’t think it’s

fundamentally sufficient. Out of modesty I think

Robin Li neglects the most critical factor of all:

founder and firm motivation. After all as our

government endlessly tells us global Britain isn’t

excluded from international markets and most

certainly not from those of American hegemony.

Indeed at times we’re welcomed as being neutral

outsiders with the right language. ARM has

benefitted hugely from not being a US company.

Spotify is beating Apple, Amazon and the music

labels without being troubled by its very

Swedish values.

So my prevailing belief is that new British companies

fail to compete at scale because they deserve to fail

not because they are doomed to do so. To put it more

bluntly: they are unsuccessful because they (and we)

are unambitious- indeed unfit for purpose.

Such a strong view needs considerable justification.

That’s why I started with Grail. At one remove this

could – should - have been a British success story

based not in Menlo Park but in Cambridge. As Kevin

Davies relates in ‘The Thousand Dollar Genome’

next generation genomic sequencing was literally

invented in a pub in Cambridge. The resultant

company was called Solexa. It was eventually

bought by Illumina for $600m as a scientific

success but total commercial failure. Illumina in turn

spun off Grail with the ambition of finding a universal

test for cancer via liquid biopsy and generating a

substantial value creation for shareholders. Illumina

itself is now valued at $37bn.

But there’s another avenue to explore before I visit

Illumina tomorrow. Roche tried to buy Illumina

for $6 billion in 2012-13. Illumina has determined

leaders but no controlling founders or families. Yet

the bid failed. Why? Because three institutional

shareholders refused to sell. We were one of the

three. Roll this forward to 2016. SoftBank tried to

buy ARM - almost certainly Britain’s sole serious

shot at building a global technology platform.

SoftBank succeeded. We were the largest

shareholder but we were alone as opposing active

managers (L&G index funds were willing to fight

too). But there wasn’t a quorum. There was a

recommendation from Board and management to

sell. Mr. Son rejoiced and went on to say that ARM

would be as valuable as Alphabet.

I



The examples roll onwards on both sides of the

Ocean. We don’t need to speculate as we know

what happens. SkyScanner was - is - a great

business but, CEO apart, the owners wanted to sell.

The only decision was to become Chinese rather

than American.

But we also need to refine the US perception.

This isn’t about America: it’s about the profound

contrast between the US of Wall St, Washington and

Trump and the US of the West and of immigrants.

The former is at least as short-term greedy and

long-term stupid as are the British mentalities. The

latter pairing is totally different. Jeff Bezos driving to

Seattle, Mark Zuckerberg deserting Harvard, Steve

Jobs returning to Apple are all just as momentous but

intrinsically Western epics as Cowboy legends. They

are also predominately immigrant stories far from

the establishment. Why is South African Elon Musk in

California? He’s clear it’s because people like him can

dream there, although the general American dream

is long over statistically speaking. Britain doesn’t

understand that outliers matter. Yet another tragedy

of Brexit is that London in the age of Trump could

have become the natural home of the determined

potential genius. That’s no longer possible.

So I think there isn’t even much need to speculate

as to our failings versus the Western fringe of

America. We fail at every level - from management

softness, to investment feebleness to societal love

of the safe return over the spectacular possibilities.

I see nothing on the horizon to change this terrible

record. It’s very sad.

Jeff Bezos

driving to Seattle,

Mark Zuckerberg

deserting Harvard,

Steve Jobs returning

to Apple are all just

as momentous

but intrinsically

Western epics as

Cowboy legends.



Change – for better or for worse?

Author

Brian ToraChartered Fellow, CISI, Consultant to JM Finn

hen I started in the business of advising private investors on

how best to structure their portfolios, the available choices

were very limited and comparatively simple. Equities, gilt

edged securities (or government bonds as we’d probably call them today)

and cash - sterling, of course – were all that were available. Back in the

mid-1960s, the provisions of the 1947 Exchange Control Act applied. Many

will remember this as limiting what you could take out of the country if

you were travelling abroad. But for investors it imposed severe penalties

on straying outside the UK for your investment opportunities.

W



in working for a progressive firm when I started out

in the City which embraced the concept of taking

investment decisions for its clients. Back then

a discretionary agreement consisted of a single

sentence – “I wish you to manage my investments

on a discretionary basis” – followed by the client’s

signature. No mention of attitude to risk or

investment objectives. But back then the universe of

private investors was actually quite small.

It all changed when Margaret Thatcher came

to power, encouraging wider share ownership

and greater competition. The Dollar Premium

surrender was abolished, closely followed by

the repeal of ECA ’47, as it was known. Investing

abroad – whether as a company or an individual,

became easy and eventually the norm as the

concept of a Global Village took hold. Meanwhile,

the number of individuals owning shares ballooned

as privatisations and demutualisations – each

accompanied with extensive advertising campaigns

– helped establish share ownership amongst a

much wider constituency than the very rich.

While investing overseas was possible, it was

expensive. Foreign currency had to be purchased

through what was known as the Dollar Premium

account, which fluctuated according to demand. I

recall that it could stand as high as 50% - perhaps

even more, meaning that to invest a pound abroad,

you had to pay £1.50. The sting came when you came

to sell as 25% of the Dollar Premium was surrendered

to the government, amounting to a tax that could rob

you of more than 10% of your investment.

The supply of corporate bonds was also limited

to the private investor. No bond funds existed, as

I recall, and this market was viewed as suitable

only for the professional investor, as like as not to

be a pension or insurance fund manager. This did

change, with ICI launching two bond issues while

I was working on the floor of the London Stock

Exchange, aimed in part at private investors.

Regulation was more limited then, too, and

discretionary management of private client

portfolios was comparatively rare. I was fortunate

Many might not remember the date, but ask anybody who remembers the 1980s about Mrs

Thatcher’s privatisations, the Tell Sid campaign will be uppermost in their minds. The plan was

to increase share ownership across the country such that it wasn’t just for the wealthy. And it

worked. Thanks to a £30m publicity campaign British Gas shares were the talk of the country as

people scrambled to get a piece of the action. The campaign, with its strapline, “if you see Sid, tell

him” helped see the number of shareholders in the UK rise to more than 11 million people.

TELL SID



Internationalisation and the encouragement of

competition led to what became known as “Big Bang”

in 1986, when traditional boundaries were swept

aside and City firms were swallowed up by financial

giants, many foreign. Against such a background,

the cosy self-regulation exercised by the Stock

Exchange became obsolete and so a regime of more

formal regulation was ushered in. Financial services

regulation has seen many changes too and I doubt

anyone could have foreseen thirty years ago the

extent of the way in which lives of both investors and

practitioners would have been impacted.

But the availability of choice and the degree of

professionalism exercised within the financial services

industry have enhanced the investment landscape

during my working life. Many asset classes that once

were only available to the very wealthy can now be

accessed by investors with more limited means –

such as commercial property and private equity. Even

hedge funds have endeavoured to widen their appeal,

though they are not suitable for many investors.

New asset classes have emerged, with funds investing

in specific sectors, such as infrastructure, now on

offer. Highly specialised funds, in terms of geographic

coverage, market capitalisation and even industry

specific, allow portfolios to be constructed in a very

targeted manner. Different investment styles can be

accommodated within funds and in bond markets the

choice has become positively overwhelming.

All this must be considered a plus, even if it presents

a bewildering array of options to the investor. Little

wonder, then, that discretionary management of

private investors’ portfolios has become such a big

business. And there is another change that affects us

all, but is particularly relevant to the investment world.

Technology has speeded the availability of information

and made more efficient the execution of trades.

When I started out on the floor of the London Stock

Exchange, news could take days to filter through to

investors. Today it is pretty much instantaneous.

I feel privileged to have worked in such a dynamic

industry for so long. It is wrong to try to label change

as being for the better or the worse. Change is

inevitable. No doubt in another half century someone

will be reflecting on the way in which the investment

world has changed during his or her working lifetime.

In the meantime we are fortunate to have the world as

our investment oyster and a professional capability to

help us take advantage of it.

When I started out on the floor of the London

Stock Exchange, news could take days to

filter through to investors. Today it is pretty

much instantaneous.

QUOTE



The FTSE No Man is an Island

defence of London-listed equities (that

make up the FTSE All Share) and an

argument for why I continue to invest in

FTSE stocks is an important aspect of any global

investing paper.

The FTSE has almost never been as unpopular as it

is now – the FT, BBC and Economist seem to have

been running almost exclusively negative headlines

on the UK ever since the Brexit referendum. A

survey of global investors made by Bank of America

Merrill Lynch in January 2018 showed that the

UK was the least popular global asset class of all.

Conversely, global banks (such as JPMorgan and

Goldman Sachs) and cash are currently the most

wanted assets for fund managers. In a recent article,

the FT quoted a European private equity investor

saying: “It would be nice if we had a UK government

that actually has a strategy … there is no strategy.”

I will revisit this comment later, but it clearly typifies

the consensus view on why international investors

are shunning UK equities. I am a natural optimist

and believe that investors are forgetting many of the

features that make London markets an attractive

place to put your savings.

Firstly, London is a heavily regulated market

where investors have a meaningful voice. It is easy

to grumble about regulators and the seemingly

Author

Fred MahonFund Manager of the Coleman Street Investment Services, JM Finn

Anever-ending new rules that they appear to be

devising at the moment, however the primary aim of

regulators is positive – the FCA’s website states that

their target is to strive for “Financial markets [that

are] honest, fair and effective so that consumers

get a fair deal”. Few markets offer such a level of

protection to investors against both government

and corporate misbehaviour. As in any market,

questionable characters emerge in London also

(Mike Ashley, Philip Green and Fred Goodwin come

to mind) but they are in a minority and, to a greater

or lesser extent, they are answerable to the law and

the public. Compare this to Korea, where Lee Kun-

hee remains as Chairman of Samsung despite being

in a coma and on trial for millions in tax evasion, or

India, where Vijay Mallya (aka “The King of Good

Times”) continues to operate many businesses

while also resisting multiple billion dollars of charges

for financial crime. No market is perfect, but some

are more perfect than others. Investors in London

markets can be confident that their assets have a

robust level of oversight.

Along similar lines, the UK Government certainly

has its problems but I am confident that

shareholders need not worry about their assets

being seized by Downing Street. To return to the

above comment from a European private equity

investor, a weak Government with a lack of strategy

is not necessarily an issue for investors taking a long



FTSE ALL SHARELARGEST FIVE COMPANIES

Royal Dutch Shell

HSBC

BP

GSK

JM Finn 100%

British American Tobacco

FTSE ALL SHARELARGEST FIVE COMPANIES

LARGEST FIVE COMPANIES

OF THE INDEX

THE REST OF THE INDEX

LIST OVERVIEW VISUAL OVERVIEW

JM Finn 100%

25%

Many of these

international

businesses found

within the FTSE are

true global leaders

in their field



JM Finn 100%



term view. Vladimir Putin and Xi Jinping clearly have

a strategy, but this seems to involve increasing their

own power and both have form when it comes to

procuring private assets for the state. A government

should be afraid of its people and, I would argue,

Mrs May is just that. Leading FTSE companies such

as HSBC, Shell and Unilever have survived through

far worse political situations than we currently have

in Westminster and will do so again.

Many of the companies listed in London should not

be considered to be “UK equities” in the traditional

sense. If a worst case scenario did play-out and

Britain fell into ruin, then the international nature of

many FTSE companies should allow for business to

continue largely unchecked. For example, the largest

five companies in the FTSE All Share (Royal Dutch

Shell, HSBC, British American Tobacco, BP and GSK)

make up around 25% of the index17 – the weighted

average exposure of these businesses to UK revenue

is just 11%, or put differently, they make 89% from

their international operations. The FTSE consists

overwhelmingly of global businesses whose future

is largely unaffected by the domestic UK economy

– they just happen to be listed in London for historic

reasons. Furthermore, many of these international

businesses found within the FTSE are true global

leaders in their field, be it the world’s largest premium

spirits maker (Diageo), Asia’s leading insurer

(Prudential), or two of the three primary iron ore

miners (Rio Tinto and BHP Billiton). Equity investors

should remember that they are trading in the shares

of individual companies and not just relying on the

fortunes of the country where these shares are listed.

I believe that markets are inefficient because

we are all human and humans tend to move in

crowds. This is good news because it presents

opportunities to those that are brave enough to

be different when they feel that the risk is worth

the reward. As I pointed out earlier, “the crowd” of

many fund managers that took Bank of America

Merrill Lynch’s survey has little interest in the FTSE

at present. In 2015, this same survey showed US

equities as the largest underweight – the S&P 500

has since risen almost 40%.

At the start of 2016 China and commodities were

least popular – the price of iron ore doubled over

2016 on the back of a surprise recovery in the

Chinese economy. This is all easy to say in hindsight,

but my point is that the market has a tendency to

overreact and that being a contrarian can be fruitful.

Peter Cundill was a fantastically successful investor

based out of Canada in the mid/late twentieth

century, known for his bravery to invest in unloved

areas of the market. Cundill famously began each

year by visiting the worst performing stock market

over the previous 12 months in search of bargains –

if Cundill was still alive today he may well have been

on a flight to Heathrow.

I continue to look for investment ideas in the FTSE

because I am happy that London provides a secure

marketplace through which to trade and where

the Government and regulators are sensible. Of

course, it is important to maintain a balanced

portfolio invested across a range of asset classes

and geographies. Within this asset allocation UK

equities continue to play an important role. We are

lucky enough to have a diverse selection of both

domestic and leading international companies

listed in London and our future investment returns

should not be at the mercy of Brexit negotiations

over the long term. Now may in fact be a wonderful

moment to be contrarian and show some support

for the FTSE.



Understanding finance

Market Cap

Number of shares * Price per share

― ― ― ―An important consideration for liquidity

purposes. Whilst some businesses may

show all the characteristics of an excellent

investment, the small size of a business

can sometimes prove a limiting investment

factor. We only want to spend time

researching businesses whose shares we

can actually buy and sell.

Return on Capital Employed

Earnings before interest and tax /Capital Employed

― ― ― ―Measures profits generated as a proportion of the capital base (debt + equity). We as

investors would like to deploy the minimum proportion of our equity to any business

for the maximum possible return (profit). Investing in a business with a high and

sustainable ROCE often gives us the best chance to do that. We use EBIT as it allows

comparison of businesses with differing levels of debt and in different tax jurisdictions.

Interest Cover

Earnings before interest and tax/interest

― ― ― ―Default risk is the chance that a company

is unable to make interest payments on

their debt obligations. A business with

low level of Net Debt/EBITDA at a very

high rate of interest may face a greater

default risk than a more highly geared

company facing an exceptionally low rate

of interest. Interest cover is a good way to

capture this risk.



FCF Margin

Free cash flow/Revenue

― ― ― ―Whilst all financial metrics have the opportunity to be massaged

by accounting practice, we believe that cash is the ultimate arbiter

of value creation. Free cash flow margin measures the amount of

cash generated by a firm as a proportion of revenue.

Fixed Charge Cover

Earnings before interest and tax + Fixed

Charges/Fixed Charges

― ― ― ―Fixed charge cover takes the interest cover ratio

a step further to include fixed charges such as

lease payments as well as interest expense. A

company with a large store estate for example,

which it might fund through operating leases

rather than debt, should have this sometimes

large expense taken into account.

EPS CAGR

Measures the compound annual

growth rate (CAGR) of earnings per

share. A high quality business should

be able to grow earnings either through

revenue growth (price or volume) or

margin improvement (cost reduction)

or a combination of all of these.

Net Debt/EBITDA

(Debt-cash)/Earnings before interest, tax,

depreciation and amortisation

― ― ― ―Provides a measure of strength of the balance

sheet. Just as someone earning £100,000

per year would be more comfortable with

a £500,000 mortgage than someone on

£20,000, a business with a small amount of

debt as a proportion of earnings would be

more comfortable than vice versa.

Return on Equity

Net income/Shareholders’ equity

― ― ― ―ROE measures net income as a

proportion of shareholders’ equity.

As with ROCE we look for businesses

able to generate significant profits with

limited equity investment.



ReferencesHard Darwin1 Innosight2 Capitalism, Socialism and Democracy, Joseph Schumpeter, 19423 MSCI4 Factset5 MSCI

The Global Economy: the driving forces6 US Department of the Treasury7 Bloomberg

Emerging Markets: still a relevant catch all asset class?8 Bank for International Settlements9 Goldman Sachs, Chine E+Commerce, shopping re-Imagined (2017)10 https://www.pwccn.com/en/retail-and-consumer/publications/total-retail-

2017-china/total-retail-survey-2017-china-cut.pdf/11 https://www.ibef.org/industry/ecommerce.aspx12 https://ecommercenews.eu/ecommerce-russia-worth-16-billion-euros-2017/13 MSCI Brazil https://www.msci.com/documents/10199/efef068e-d252-4e75-

8142-2c8b8f441759

Why our backyard is too small14 Bloomberg as at the 27th of March 201815 MSCI as at 28th of February 201816 Investing the Templeton Way by Lauren C. Templeton

The FTSE – No Man is an Island17 Source: Bloomberg



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